Look to the Land of the Rising Sun for Stocks and Shares ISA Returns

While the bull run for equities in the UK, USA and Europe looks as though it might yet have some legs, with prices at or close to record peaks they can’t, of course, keep going up. No one quite knows when a correction will happen, with the only certainty that it will eventually. Gains towards the tail end of an equities bull run can be among the best but holding on for too long is of course the mistake every investor wants to avoid. Values are at the point where many investors will have started to hedge against an impending correction.

UK investors with stocks and shares ISAs, or investment portfolios held outside of the tax efficient wrappers of an ISA, or SIPP, have been increasing their cash allocations over the past year as a hedge against an impending correction. This is often done by keeping dividends as cash rather than reinvesting them in the same companies.

With the stock market correction feared not yet having materialised, many will be looking at the cash piling up and wondering whether they might not be making a mistake not reinvesting it as new record highs are hit. For those not intending to retire soon, putting that cash back to work by investing it, while doing so in securities less correlated to the UK and US has merit as a strategy.

As investors look to diversify out of fattened Western equities markets, some eyes have turned to a stock market long out of fashion with UK investors. 30 years ago, Japan had the biggest stock market in the world. In the 1980s, the big Japanese technology companies and manufacturers dominated the world. The golden era for Japan’s economy and stock market famously came to an end in 1989 as the Nikkei plunged in value. Having lost decades to deflation, however, the Land of the Rising Sun appears to be on the up again. Prime Minister Shinzo Abe’s ‘Abenomics’ strategy of monetary easing, fiscal stimulus and structural reform have reinvigorated Japan’s economy.

Despite the general economic revival, the Nikkei index still stands at close to half its 1989 pre-crash value. In the context of the global equities bull run, gains in Japan have been modest. It’s the only major stock market in the world whose price to earnings ratio is currently lower than its average for the current century to date. JP Morgan estimates that the average Tokyo Stock Exchange company is valued at 14.3 years forecast earnings, while the long term average is 15.4.

A Sunday Times article reports that in comparison, UK equities are currently trading at a 14.3 P/E ratio compared to a long term average of 12.4, while over in the US valuation have hit multiple of 18 against a 14.8 average. Globally, equities that form the All Country World Index have an average P/E multiple of 16, when their average is 13.7.

Yesterday, while voter turnout was low, indicating a lack of enthusiasm for the choices on offer and general political apathy, Abe decisively won a snap general election. He will now remain at the helm for the foreseeable future and likely become Japan’s longest-serving prime minister. Abe is benefiting from a lack of serious opposition, there are doubts about his nationalist agenda and a recent corruption scandal saw support for him wane, prior to the election which he fought on promises to protect Japan from an increasingly belligerent regional threat from North Korea. However, Abe-nomics seems to be, at least to some extent, lubricating the economy and there is now hope that the Tokyo Stock Exchange’s long period of decline and stagnation may not be permanent, as once feared.

Japanese equities have seen other false dawns over the years but there seems to be something more substantial to this one. Darius McDermott, Chelsea Financial Services’ managing director, points to the fact that “Japan’s economy has grown for six consecutive quarters, something that has not happened for 12 years, and corporate profits have risen by about 30% over the past year.”

Dividends also increased by an average of 23% last year and Abe has been pushing Japanese companies, which have traditionally been hoarders, to distribute more cash to shareholders. While admittedly starting from a very low base, Japanese equities hold the promise of increasing dividends in coming years.

McDermott believes that, while there are risks, not least of which is the potential for nuclear war with North Korea, UK investors appear to be ignoring an ‘inflection point’ for Japanese equities. Last month, UK investors put three and eight times as much capital into US and European funds respectively as they did into Japanese. While many experts have been predicting the end of the current bull market in the US, UK and Europe for over a year now, and have been proven wrong, it is worth noting that the 1987 stock market crash which decimated bench mark indices in the US and UK, had little impact on the Nikkei. It continued to rise until its own 1989 crash.

With Japanese equity values currently so low compared to the rest of the world, there is a strong argument to add some exposure as part of a stocks and shares ISA portfolio. There is both good potential for capital gains as well as increasing dividends.

The Sunday Times asked a selection of investment experts to pick their favourite Japanese Equities funds that stocks and shares ISA investors can invest in. The Share Centre’s Sheridan Admans tips the Fidelity Japan Smaller Companies fund, which has provided combined returns of 156% over five years and has a 0.99% annual charge.

Architas’ Adrian Lowcock highlights 3 funds of varying risk profiles he believes stocks and shares ISA investors should look at. The first is the Man GLG Japan CoreAlpha fund. It is focused on Japanese blue chips such as the big automobile manufacturers, has returned 134% over 5 years and charges 0.9% annually. Lowcock’s second pick is the Baillie Gifford Japanese fund which has returned 162% over the past 5 years and comes with a 0.63% charge. Finally, with a higher risk profile due to the fact the fund’s managers are permitted to take ‘short’ positions, is the Pictet Japanese Equity Opportunities fund. It’s delivered 127% over the past 5 years. Fees are an annual 1.04%.

Passive tracker funds are also an option for those who prefer not to hope their fund’s managers manage to beat the market. The cheapest currently available is Fidelity’s Index Japan fund, which charges an annual 0.1% and has returned 63% since 2014, when it was launched.

The second of only two ‘Gold’ rating ETFs offering broad exposure to Japanese equities, is the Vanguard FTSE Japan ETF. Narrower than iShares’ offering, with 480 constituents, Morningstar believes the ETF still offers a very good proxy for the Japanese equity markets. Annual charges are 0.19%.

The third choice is the Lyxor Japan TOPIX DR ETF D-EUR A/I, which covers 2000 Japanese companies and is, according to Morningstar, approximates total market exposure. It’s only downfall, which reduces its Morningstar rating to ‘Silver’ is that it has relatively high charges for an ETF, at 0.49%.

Risk Warning:

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.